Matthews Japan Fund Second Quarter 2013 Commentary
The quarter was a roller coaster ride for Japan investors, marked by strong gains until mid-quarter followed by a sharp correction toward the latter half of the period. The quarter began with the Bank of Japan (BOJ) announcing a larger-than-expected quantitative easing measure that propelled Japan's equity markets to five-year highs. Overseas investors were the primary drivers of the rally, pouring roughly US$46 billion into Japanese equities during the quarter. The yen also weakened considerably against the dollar, breaking above 100 yen against the U.S. dollar mark for the first time since April 2009. This bull market turned rather abruptly after comments from the U.S. Federal Reserve regarding a possible exit from its quantitative easing measures that prompted widespread profit-taking activity. However, despite the sharp correction, the market managed to eke out a modest gain at the end of the second quarter as volatility gradually subsided.
The most notable event of the quarter was the massive quantitative easing announced by the BOJ under new leadership by Governor Haruhiko Kuroda. To achieve its 2% inflation goal, the central bank intends to roughly double Japan's monetary base, a measure of currency in circulation, to approximately US$2.7 trillion, primarily through the purchase of Japanese government bonds. The BOJ also intends to buy longer dated bonds to raise the duration of its bond portfolio from three to seven years. Data also shows that the BOJ is purchasing bonds at a much faster pace than originally expected in response to a rise in long-term interest rates. These easing measures stand in stark contrast to those of the U.S. Federal Reserve, which outlined an exit scenario from its own quantitative easing measures after a policy meeting in June. The difference in central bank policies may gradually be reflected in currency exchange rates in coming quarters.
In such a market environment, we have continued to focus our efforts on identifying individual investment opportunities through bottom-up fundamental research. Stock selection was the primary driver of outperformance.
Nuflare Technology (TSE:6256), a manufacturer of electron beam equipment used in semiconductor production, contributed substantially to outperformance. Nuflare currently holds a virtual monopoly in the supply of electron beam mask writers and is expected to benefit from favorable pricing trends as well as a recovery in orders for semiconductor production equipment.
Auto firms, such as Toyota Motor (NYSE:TM) and Fuji Heavy Industries (TSE:7270), generated notable absolute gains for the Fund during the quarter. These stocks were buoyed by the weakening yen, as well as a continued improvement in the U.S. auto market in which these firms derive a large portion of their business. We believe there is potential for Japanese automakers to improve their competitive position in the years to come as the downward pressure from a strong yen has reversed course.
On the other hand, our intentionally limited exposure to the utilities sector posed the biggest drag on relative performance. Electric power companies performed well on the back of heightened expectations for the restart of the country's nuclear power plants. The Nuclear Regulatory Authority is scheduled to finalize its guidelines on safety requirements that should pave the way for a resurgence in Japan's nuclear power generation and may ultimately result in improved earnings for power companies. We continue to avoid this sector, however, as we view management quality to be poor and prospects for long-term growth to be limited.
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